Transportation Funding Findings to Date and Conclusions Reached

We have talked much about needing more money for our roads and bridges. For those not intimately involved in those discussions, here is a summary of the findings of various studies done in recent years:

1. TF2 Report.  In 2008, the Transportation Funding Task Force (TF2) recommended that the state increase investment (and accompanying revenue) $3 billion to achieve its “good” option for transportation (considering all transportation needs, including roads, bridges, addressing safety issues, increasing capacity, rail, transit and aviation).

2. House Transportation Committee Work Group. The September, 2011 report “Michigan’s Road Crisis: What Will It Take to Maintain Our Roads and Bridges?” reported on what it would take to just preserve our existing road surfaces and bridges and achieve over a 12 year period 95% of the freeways and 85% of all other paved roads in the state at a “good” or “fair” condition. It found that it would take an investment of at least $1.4 billion more per year than current spending. The study used the asset management approach of what would be the least cost long-term combination of “fixes” and timing of fixes to maintaining the value of the state’s assets of roads and bridges – a business approach. This approach emphasizes doing the capital preventive maintenance to avoid the much higher cost “fixes” of rehabilitation or reconstruction necessary much sooner in the road life than if the capital preventive maintenance is not done.

3. House Transportation Committee Work Group Update. The “Michigan’s Road Crisis: What Will It Take to Maintain Our Roads and Bridges? 2012 Update” released in March, 2012 indicated that the shortfall to achieve the 95%/85% goals had risen to $1.542 billion per year and rising over the 12 years studied. This study was updated to reflect the year delay from 2012 that the first additional moneys were assumed to be available in the initial study due to the failure to achieve any funding increases in 2011. The study also utilized additional road condition data unavailable in 2011. The study also found that the year’s delay will cost the hardworking taxpayers in the state an additional $1.8 billion over the next 12 years compared to the costs had the legislature acted in 2011.

4. TRIP Report. “Where Are We Going? Current and Future Pavement and Bridge Conditions, Safety, and Congestion Levels of Michigan’s Roadways and the Impact on Michigan Households, Based on Investment Levels over the Next Decade,” was issued by TRIP, a Washington, DC, based national transportation research organization in late March, 2012. The report concluded: “Increased transportation investment is critical to Michigan's economic recovery and to lower costs for state's residents; each Michigan household could save nearly $2,000 annually by 2022 if funding is increased to allow for significant improvements.”

5. Phase In? Another run of the funding model was run to see what the result would be if the legislature were to phase in funding increases of $200 million the first year, then $400 million, then $600 million, then $800 million and finally $1 billion, rather than do a $1.4 billion increase all at once. The result was that, although these amounts of money are far better than no additional money, we would actually see a decrease in the average quality of our roads in the future from the current condition. That is, the roads would still be deteriorating faster than the capital improvements to them.

6. Just Maintain Our Current Poor Quality? The House Transportation Committee Work Group set the 95%/85% goals and then sought to see what the lowest cost combination of “fixes” and timing of “fixes” was to derive the additional funding needed. A follow up question was asked, “What would it take to just maintain the road conditions with no average road system improvement?” The funding model was again used and the following was the result (i.e., we would still need over $1 billion more per year, and rising):

Year	Total Funds Needed to Maintain Roads in 2011 Condition	Total Additional Funding Above Current Investment Needed to Maintain 2011 Condition
(millions)	(millions)
2013	$2,796.95	$1,104.53
2014	$2,796.42	$1,104.00
2015	$2,700.99	$1,008.57
2016	$2,276.56	$584.09
2017	$2,567.96	$875.14
2018	$2,734.69	$1,042.25
2019	$2,916.46	$1,224.16
2020	$3,062.21	$1,369.87
2021	$3,035.90	$1,342.37
2022	$3,012.37	$1,320.52
2023	$3,122.45	$1,429.25
2024	$3,315.41	$1,623.00
2025	$3,485.79	$1,793.37
Total	$37,824.16	$15,821.15
Avg	$2,909.55	$1,217.01

7. Anderson Economic Group/Michigan Chamber Foundation. The economic report entitled “Economic Impact and Policy Analysis of Four Michigan Transportation Investment Proposals” (June, 2012), which was commissioned by the Michigan Chamber Foundation and prepared by Anderson Economic Group (AEG), concludes that:
   1. funding for Michigan roads has declined in both real and nominal terms in the past decade – fuel taxes have not been indexed to inflation and those funds do not stretch as far as construction costs have escalated,
   2. the quality of Michigan’s roads will decline rapidly if more funding is not raised for additional repairs and maintenance,
   3. fixing the rest of the state’s deteriorating roads and bridges would create an additional 11,000 jobs,
   4. money invested in roads and bridges has a higher economic multiplier than household spending because some of the money would have otherwise been spent out of state and because road construction work and its related supply chain is based largely in state. The study estimated the net economic benefit of these scenarios by accounting for both the benefits of infrastructure spending and the costs associated with forgone expenditures by taxpayers (which negative impact is rarely seen in economic impact studies justifying a special interest group’s position),
   5. job providers benefit from a well-maintained infrastructure, and
   6. the four most talked-about funding proposals of $1.4 billion additional road funding would provide adequate funding to complete the necessary infrastructure repairs, with increased wholesale gas taxes and vehicle registration fees – or some combination of the two – all very close in terms of the economic boost they would provide to the state.

Conclusions Reached:

1. We need at least $1.542 additional funding or savings to maintain our roads and bridges and achieve the 95%/85% good or fair condition in the next 12 years.

2. To avoid another $1.8 billion cost to the taxpayers caused by delay, action needs to be taken timely in 2012 to avoid missing the 2013 construction year as well. Time is not on our side.

3. We need to be bold in filling the funding gap in one fell swoop, as incrementalism does not achieve the goals.

4. Doing less than the total need would expend considerable political capital and end up disappointing the taxpayers with higher costs, but no better roads. That is, if we are to take action, we might as well achieve the goals, rather than take the potential political heat for the higher costs AND still have poor roads.

5. While it will cost motorists money in terms of higher gas taxes and vehicle registration fees, there will be offsetting savings in vehicle repairs, longer life vehicles, safety, etc.

6. There are both short term job benefits and long-term benefits of creating an environment for businesses to flourish from maintaining our roads and bridges.

Solid Information and Analysis Trumps Ideology with MPSERS

The Capitol Confidential article “House GOP Hides Behind Rigged 'Study'” dated June 18, 2012 http://www.michigancapitolconfidential.com/17075 is wrong.

When our House four member Work Group on MPSERS began our work months ago, we all leaned toward having all new employees in the school systems enrolled into a defined contribution plan instead of the “hybrid” plan begun with legislation in 2010. Then we learned that if we were to be consistent in providing school employees with what the state employees’ received through their defined contribution plan, the costs may actually be higher than what the state would incur with the hybrid plan.

How can this be, when the current MPSERS employer contribution rates are 25% and rising? First we need to dissect what is contained in the current contribution rates. Of the 27.37% contribution rate for fiscal year 2012-13 for employees hired before July 1, 2010, 15.86% is for the Pension Unfunded Accrued Liability, 2.66% is for the Early Retirement Incentive enacted in 2010 amortized over 5 years, 8.75% is for Retiree Health Care, and only 3.47% is the “Pension Normal Rate”. The “normal” cost is the amount needed to fund the pension benefits earned in that year according to the actuaries’ calculations. This is the rate that must be compared with the cost of a defined contribution plan.

For state employees, the state pays 4% of wages, plus matches up to 3% more if the employee voluntarily contributes into the plan, for a maximum of 7%. The actual history is the state paying about 6.2%, because all employees do not contribute the amount necessary for that state to reach the 3% maximum match. So, knowing that the hybrid plan is much less rich a benefit plan than for employees hired prior to July 1, 2012, we asked what the “normal cost” was for employees in the hybrid plan. We learned that they were 2.24% for fiscal year 2013 and 2.67% in fiscal year 2014. Hmm, these costs were lower than 6.2%. If we wished to reduce the cost of the MPSERS program to employees, did it make sense to adopt a plan that was higher cost? We opted to recommend sticking with the hybrid plan for new employees.

The Senate adopted a version of SB 1040 that would have closed out the defined benefit plan and placed all new employees into a defined contribution plan. This would have the effect under Government Accounting Standards Board guidelines of requiring a quicker amortization of the unfunded liability than if we stuck with the existing plan. This would make it difficult to do both the pre-funding of the health care benefits that the House favored and funding the amount that the GASB rules indicated needed to be reported as the “annual required contribution” (“ARC”).

We in the House recognized that we did not have all of the information we needed to make a fully informed decision to close the defined benefit program and adopt the defined contribution plan the Senate preferred.

• That is, the lower normal cost of the hybrid plan is a calculated percentage, based on certain assumptions, including a 7% investment rate of return. We want to see some sensitivity analysis of what the cost would be if the actual rate of return were 6%, 5%, 4%, etc. While we will not be able to predict exactly what the future investment return will be, we would know how sensitive the calculated cost of the hybrid plan is to different investment rates.
  
  Any defined benefit plan, including the hybrid plan, contains the risk that the assumptions used by the actuaries in calculating the “normal cost” are overly optimistic. If the cost of the hybrid plan assuming a 6% investment rate of return is greater than the 6.2% cost likely under a defined contribution plan, we might well decide that adopting the defined contribution plan makes sense. If such a small variance from the actuaries’ assumptions makes such large difference in actual cost, the risk is high that the hybrid plan might end up more expensive than the defined contribution plan that does not rely on assumptions. It might make sense to eliminate that risk altogether and adopt the defined contribution plan. On the other hand, if the cost of the hybrid plan is still cheaper with a 2% investment rate of return, sticking with the hybrid plan would most likely be less costly in the long run.
  
• Further, the proponents of the defined contribution program claimed that the state was not required to actually fund the program according to the amounts calculated and reported in the financial statements as required by GASB. We don’t know how the bond rating agencies would react to the state failing to fund the ARC. The study is intended to allow time for our bonding professionals to contact the key bonding agencies and attempt to determine what their reaction might be if that were to occur.

With the results of the study this fall, it may turn out that the risk is low that the defined benefit plan will be more costly and that the bonding agencies will not adversely rate our state’s bonds if we were to close out the defined benefit plan but not fully fund the ARC. If so, then it may make sense to take this step, in addition to the pre-funding of the health care benefits as planned in the H-3 substitute Senate Bill 1040 as passed by the House of Representatives.

If not, we will have made significant progress to bringing the costs of the MPSERS program under control, capped the contribution rate employers would pay, reduced the unfunded liability an estimated $15.6 billion, taken a stride toward taking care of the “stranded cost” problem, and all while being reasonable with our valued public school employees and retirees.

This is a case where solid information and analysis trumped the ideological arguments made by the Mackinac Center when the House approved its version of SB 1040.

SB 1040 MPSERS Reform Necessary

(This is the speech I gave on the floor of the House on June 13 in support of the House (H-3 substitute) version of Senate Bill 1040, which would reform the Michigan Public School Employee Retirement System and put it on a solid financial foundation.)

I rise to support this proposal to reform the MPSERS program. The changes proposed will put the program on a sound footing and ensure that the benefits offered by the program will in fact be able to be paid when they come due.

The first step in solving any problem is clearly defining it. Here the problems are:

1. An Unfunded Liability totaling $45.2 Billion according to the last Comprehensive Annual Financial Report, and the CAFR expected soon will probably show that to be over $50 billion.
   
2. The contribution rates that employers pay into the system are projected to grow from 25.7% this year to 35% in just 5 years. This is compared with 12.17% in 2000 that we thought was outrageous when I became the business manager at Adrian Public Schools.
   
3. This is a tremendous burden on our schools which takes away money that could otherwise be used for educating the kids. This year, the total contributions into the system is about $1,635 per student, and if we do nothing, $2,552 in 2016-17.

Three Potential Solutions

• Increase employee contributions
• Decrease benefits
• Find additional money

This proposed solution uses all three

This H-3 Proposal:

• Increases employee contribution to 4% for Basic members and 7% for Member Investment Plan (MIP) members. This is not much of an increase from 6.4% for some employees who have been employed since July 1, 2008, while the increase will be a bit higher for longer term employees. Nonetheless, we cannot continue retirement plans that promised more than the state can afford to fund. At the same time, we should acknowledge the efforts of prior legislatures that have tightened the programs through the years. For example,
• Hybrid retirement plan adopted in 2010 will be continued for new employees
• Same health care options for new employees as state employees
• Retirees would pay 20% of their health care, other than those who are age 65 and retired by 1/1/2013
• Total prefunding of health care – instead of the fiscally irresponsible “pay as you go” method of not paying for the benefits as they are earned
• Partially fund the health care plan by continuing employee 3% contribution for health care, placed into individual accounts
• Total prefunding of health care by $603 million additional funding, spread over 2013-2018
• $470 million in health care escrow account
• $133 million in 2011-12 MPSERS set aside

Goals of Reform

• Decrease the unfunded liability
• Lower future projected contribution rates
• Be reasonable with current retirees, current employees and offer reasonable fringe benefits to prospective employees

This proposed solution achieves all three

Fiscal Impact of H-1

• Unfunded liability reduced by $15.6 billion. This is a "game changer" and will send a strong message that Michigan is serious about addressing its fiscal challenges. In all fairness, note that this is comprised of about $5 billion of real savings and about another $10 billion of reductions to the unfunded liability due to changed actuarial assumptions allowed by the GASB rules because we are beginning to fully fund the health care portion of the program.
  
• Cap the employer contribution rate at 24.46%, assuming state payments continue to fully fund the health care program in future years. In the spirit of full disclosure, it must be noted that the cap on MPSERS contributions will have an Impact on future Per Pupil Foundation Grant amounts, dampening the potential future foundation grant increases.

We need to strike a balance between the effects on employees vs. making a difference long-term in reforming the system. I am well aware of the many good people I have worked with in our schools through the years. Again in the spirit of full disclosure, my wife is a vested member of the MPSERS system and I am a non-vested member.

Let's look at the Reasonableness to Employees. Under the H-3 proposal:

• The current employee contribution rates of 4% and 7% are on the high side when compared with other states, although comparing apples to apples is difficult.
  
• When we compare the ratio of the burden placed on the employee versus the burden placed on the employer, the proposal's implied employee responsibility of 20% for Basic members and 33% for MIP members is less than the 43% borne by state employees’, and yet the school employees do not bear the market risks of the defined contribution plan that state employees do.
  
• The employees (past, current and future) bear about $9 billion of the total $45.2 billion unfunded liability prior to changes, or 20% of the total burden, with the employer picking up the remainder. From these last two comparisons, you can see that any claim that we are "balancing this problem solely on the backs of the employees" is totally wrong.
  
• Retirees will pay more, but the "granny" provision retaining the 10% cost share for those who are age 65 and retired on January 1, 2013 will protect the aged.

Conclusion: No one wants to pay more or receive less. Nonetheless, the $45-50 billion unfunded liability problem must be solved. On balance, this is a reasonable sharing of the burden.

Stranded Costs: “Stranded costs” are caused when an employee leaves the system as an employee with vested retirement or health care benefits, with unfunded liability associated with them, but with no requirement for either the employee or employer to fund that unfunded liability.

If the stranded cost problem is not addressed now, it is equivalent to sitting in a boat swamped with water, bailing furiously to get the water out of the boat, but failing to plug the hole in the bottom of the boat.

I am pleased that the proposal contains a solution to the stranded cost problem via the COE or "current operating expenditures" mechanism. Beginning in 2013-14 fiscal year for traditional public schools, their total MPSERS assessment will be split into two parts:

• 11.9% will be applied to Current Operating Expenditures and
• 3.5% will be applied to payroll to cover the normal costs for the revised retirement and healthcare benefits. Together, this is equivalent to 24.46% of systemwide payroll.

Other entities would pay 24.46% on payroll, because of their vastly different cost structures.

It is unfortunate that this reform proposal is complex, but this is just one of many complex issues we have been given the opportunity to address. Please join me in supporting this historic reform measure.